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September 7, 2010

SEC Chief Schapiro Talks About Market Structure, 'Flash Crash'

Schapiro speaks to Economic Club of New York

SEC Chairman Mary Schapiro spoke about "Strengthening Our Equity Market Structure" to The Economic Club of New York on Tuesday, September 7. After an introduction by the new Economic Club Chairman, Andrew Tisch, Schapiro noted that there were two past SEC chairmen sitting with her on the dais: Harvey Pitt and William Donaldson. Speaking about "Market Structure," Schapiro addressed some of the issues that remained after the May 6 "Flash Crash" and what the SEC was doing to try to prevent a recurrence of that record volatility.

Schapiro spoke of the declining market share of the New York Stock Exchange (NYSE), which now "executes approximately 26% of the volume in its listed stocks." The rest is "split among 10 public exchanges, more than 30 dark pools, and more than 200 internalizing broker-dealers." She noted that "nearly 30% of the volume in U.S.-listed equities is executed in venues that do not display their liquidity or make it generally available to the public."

In addition, some of the rules that apply to exchanges and market makers do not apply, yet, to some of these other electronic exchange-like entities. Should, for example, these electronic entities be allowed to just stop trading in times of stress--when exchanges and market makers must continue to make a market? Some of the firms that are "very active" in providing liquidity are not even broker-dealers, Schapiro said. Should they be allowed to "fall entirely outside the regime for regulated entities," like exchanges or market makers?

Schapiro also noted that electronic trading systems at high frequency trading firms can "generate more than a million trades" a day, and "represent more than 50% of equity market volume." But they often make, and then, in fractions of a second or mere seconds, cancel some of those orders. "Many firms," Schapiro said, "will generate 90 or more orders for each executed trade." That means "a firm that trades one million times per day may submit 90 million or more orders that are cancelled."

Particularly as this may relate to the May 6 "Flash Crash," the SEC is continuing to "address weaknesses" in market structure that could have contributed to the severity of the May 6 volatility. There has been a related loss of investor confidence in the markets as a result of the crash. Schapiro said that "retail brokers dealers have told" SEC that "individual investors have pulled back from participating in the equity markets since May 6." What's more, the chairman pointed to an outflow from retail mutual funds, "every single week since May 6."

After her speech, Donaldson asked Schapiro if current levels of funding were adequate for all the SEC was required to do, especially in light of the new mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Congress appropriates funding for the SEC each year, even though the SEC raises through its fees for securities registration and transfer much more than what Congress parcels out to the agency. In some years, the SEC takes in hundreds of millions more in fees than Congress doles out to the agency. It is, politically speaking, a way for Congress--

which receives an enormous amount of funding from financial services firms--to help these big constituents keep a tight grip on how much the SEC can do to protect investors and regulate the entities it oversees.

This congressional appropriation had been waning the years leading up to the current crisis, and the yearly appropriation made it impossible for the SEC to budget for multiyear projects like essential technology upgrades and other capital expenditures. See related blog post, "SEC Funding Needs to Change."

Pointedly, Donaldson asked whether the "politically-influenced resource planning" of the congressional appropriation for the SEC will be enough?

Shapiro explained to the packed luncheon that though the agency has "suffered for a long period from insufficient congressional [appropriations]," Dodd-Frank included "significant budget increases" that allow some of the gaps to be closed--including the SEC's ability to "finally build some technology that [it] is desperately in need of."

Verizon Chairman and CEO Ivan Seidenberg--who is also chairman of the Business Roundtable--asked Schapiro to comment on the "massive new layers of regulation," in the Dodd-Frank Act, and whether it will be so cumbersome for companies to adhere to that it "destroys the ability of capital to form..." and is the SEC "willing to phase in some of the requirements?"

Schapiro noted that the SEC was "required to meet statutory deadlines" for the tasks required in Dodd-Frank, so it's not as if they have a choice of what to implement and what to table for a later time. She asserted that the SEC was "committed to a public and transparent process" as it conducted the "100-plus rules, more than 20 studies" required of the SEC by the Dodd-Frank Act.

The costs to businesses meeting new requirements "are hard to determine" overall, Schapiro said, but she noted that the agency did a "cost-benefit analysis for every rule and will publish that for public comment."

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